THEORETICAL FRAMEWORK STOCK RETURN VOLATILITY AND COINTEGRATION OF U.S. AND ASIAN MARKETS IN ACCORDANCE WITH THE FINANCIAL CRISIS (1997-2014).
CHAPTER II
THEORETICAL FRAMEWORK
2.1.
Theoretical Background
This chapter will discuss and review the theoretical concept that would be
used as the basic ideas in this research. This discussion would be a guide to help
understand and give insight to solved the problem in this research. Looking through
the importance of the nature of the stock, it is important to understand how the
behavior of stock in a country itself and how the global economic changes affect it,
there are several studies that has been conducted by the researchers that examining
stock markets during economic crisis. Focusing on three main key variables to
understand the connection between economic cycles and stock return volatility there
are consist of stock return volatility, risk premium, also information asymmetry.
2.1.1. US and Asian market
US market is well known as the biggest market and the changes that happened
in this market will surely affected the other countries whether it is direct or indirect
and that‟s the reason why the integration or interrelationship of the biggest market
and other markets should be conducted. Meanwhile despite the biggest market,
there‟s also market that keep growing which is the East Asian market. East Asian
countries have reaches certain dynamic growth with the high levels of investment and
savings, this countries has attracted the corporates attention and also the western
11
investors. From the western point of view, east Asian countries are seen as the
potential source of funds and investor sees this as a good opportunity to make their
international portfolio in order to spread or minimized the risk in their portfolio.
That‟s why it would be interesting to analyze the behavior of the Asian markets and
how does these markets react toward the global economic events. (Swaha, 1993)
2.1.2. Global Economic Events
With the globalization and the development in the technology, capital markets
of each country are closely interconnected to one another. As a result of global
economic events many countries were affected whether it is direct or indirect way.
Some countries will become unstable and suffer from the events and that‟s the reason
why the effect of the global economic events that happened need to be analyzed by
the researchers.
Lukanima and Swaray have provided the periodical sampling of
each global economic event that has happened even since 1990, which shows in the
table below.
12
Table 2.1
Periodical Sampling of Global Economic Events since 1990
Global Economic Events
Pre Asian Financial Crisis
(02/02/1990 – 01/07/1997)
The Asian Financial Crisis
(02/01/1997 – 30/03/1999)
The Post Asian Economic
Crisis
(01/04/1999 – 31/12/2002)
The Global Economic
Boom
(02/01-2003 – 31/07/2007)
The pre Global Financial
Crisis
(01/08/2007 – 16/03/2008)
The Global Financial Crisis
(17/03/2008 – 31/03/2009)
The Post Crisis: Economic
Recovery
(01/04/2009 – 30/04/2010)
The Greece Debt Crisis
(01/05/2010 – 15/12/2011)
Description of Economic Condition
The period of prelude to the 1997 crisis
The beginning crisis in Thailand of Thai Baht
financial collapse followed by the Thai government
decision.
The economic recovery where by the end of 2002,
countries that were affected by the Asian Financial
Crisis had slowly recover.
Economic boom resulted from four major factors
consist of high commodity prices, booming
international trade, exceptional financing conditions,
and high levels of remittances.
The beginning of the U.S. crisis which reverse the
global economic boom condition
US Investment Bank collapsed resulted to the Global
Financial Crisis.
The recovery period which shown by the
improvement of the stock performance
Greek governments have been consistently and
deliberately misreported the country‟s economic
statistics and this resulted to the fear from the market.
The “road to recovery” where many public
companies started to recover.
Post Crisis Period: Greece
Crisis
(16/12/2011 – 31/06/2014 )
Source: Lukanima and Swaray (2013: 56); Stunda (2014:43)
2.1.3. Stock Return Volatility
Stock price volatility received great attention for investors and it is
important aspect that need to be understand before deciding to invest money in
the market. There are several research that has been conducted regarding the
13
behaviour of the stock return volatility (Urooj et al, 2009; Mishra and Rahman,
2010).
Urooj et al. (2009) in their research, they examine the stock volatility of
KSE 100/ Karachi stock exchange from period November 1992 to January
2008. By using ARCH/GARCH model, the researcher has found that KSE 100
has volatility clastering, leptokurtosis and asymmetry and they found that
there‟s pattern existed in the stock price returns in this market.
Mishra and Rahman (2010) analyzed the dynamics of stock return
volatility on India and Japan. They implement the TGARCH-M model in their
research. Based on their research they found that the Japan stock market is
more effiencient compared to India. They also found the evidence of the effect
of asymmetric information in both countries, it shown by how India‟s market is
affected by the good news, meanwhile Japan is more influenced to the bad
news.
2.1.4. Risk Premium
Risk premium is one of the great interest that need to be considered by the
investor as their bear the risk from the market.
Dictionary of Financial And Business Terms defined risk premium as “the
reward for holding rhe risky market portfolio rather than the risk-free asset.
The spread between Treasury and non-Treasury bonds of comparable
maturity.” (p.124)
14
With the global crisis that has happened, it gives significant impact toward the
market especially it effects the risk and return of the market. Several research has
been conducted to understand how the global crisis able to affect the risk premium of
the market. One of the research by Bishop et al. (2011) found the link between
increases in the market risk toward the decreases in equity values. In their studies,
they suggest to adjust the market risk premium to reflect the global financial crisis
with the use of historical average MRP or forward looking risk premium which used
to estimate the cost of equity. Using this methodology, they would expect a view of
forward cost of equity which is consistent with the current condition of the market
and with the debt spreads.
On the other hand, the study by Hall (2012) that responses toward the
previous study point out the inconsistency of the adjustment of risk premium to
reflect the global financial crisis by Bishop et al. (2011). In his paper, he underlying
the fundamental inconsistency with its measurement problems especially between the
short term and long term MRP. But still this kind of issues are still being debatable
until these days and more research should be conducted to help investor and give
broaden knowledge in the financial studies in the future.
2.1.5. Information Asymmetry
According to Kolb and Rodriguez‟s (1992) book of Financial Management,
information asymmetry or asymmetric information is the situation in which investor
has the same information regarding the firm, in which not every information they get
15
are the same or condition where two parties possess information about same subject
and the information itself has different value.
This information asymmetry appears anywhere and has been conducted by
many researchers. One of the examples is shown by Chang (2003) who analyzes the
barriers to information flow in which examined the information asymmetry happened
in emerging market by studying and comparing between foreign and expatriate
analysts. The researcher uses the daily data of stock price of TSE or Taiwan Stock
Exchange and also listed companies data. In this research, it was underlined that the
expatriates‟ trade on their superior information, while foreign does not trade on their
information, but by having expatriate recommendations. The result of this research
shows that the expatriate analysts outperform foreign on the profitability of
portfolios.
2.1.6. Co-integration
Globalization has resulted to the closely interconnection of each countries and
it easily influence the economic condition of each countries with this basic, the cointegration test has been conducted by many researchers in order to examine the long
run relationship among selected variables. The relationship among stock markets also
has been examined by many researchers and their result remain controversial. Zerren
and Koc (2013) analyzed the integration between Turkey stock markets and G8
countries consist of US, UK, Japan, France, Germany and Canada. In their research
they found the cointegration of Turkey and these countries in long term relation. By
16
conducted the co-integration test it will influence the investor decision in making
their portfolio especially in order to decrease the risk of their portfolio.
Recent study by Sum (2013) also conducted the co-integration test between
United States and Europe and in his research, with the changes that happened in the
structural policy of one country it can give a direct or indirect effect toward the others
that‟s why by taking this into consideration, Sum also put the economic policy
uncertainty that has happened in the countries into account . The research has found
the long run interconnections in economic policy uncertainty by looking through the
economic conditions between US and European countries.
Royfaizal et al. (2009) investigated the international linkages or relationship
between ASEAN and US stock markets. In this research, the sample of ASEAN
countries used mainly are Malaysia, Singapore, Philippines, Thailand, Indonesia,
China, Japan, and Korea. All of these countries are thoroughly investigated its
relation with US markets since the ASIAN financial crisis. Using the co-integration
test, they come into conclusion that there‟s no significant co-integration among
ASEAN and US markets on pre-crisis period, meanwhile during crisis and post-crisis
period there‟s long run relationship in those stock markets between those countries.
Kassim (2012) investigated the nature of stock market integration by
examining Malaysian stock market with two biggest stock markets which are US and
Japan‟s stock market. By conducted the co-integration tests which able to examine
the existence of long-run relationship among variables. The research findings shows
the nature of integration among Malaysian stock market with US also Japan changes
17
over period of crisis that‟s why this study proof the country‟s vulnerability toward the
financial shocks.
Dobano (2013) tried to analyze the causal relationship between fluctuations in
Latin American stock market after financial crisis using Granger Causality test. This
research investigates the short run and long run relationship by see the possibilities of
difference in returns. From this research it shows that there‟s actually no significant
difference in mean returns. And from the evidence of short run and long run
performance, it reflect that in the short run, among international indices there‟s
bidirectional causality, but this is not the case with the emerging stock indices with
international stock indices. Meanwhile in the long run, there‟s co-integration between
Latin American Indices and international indices which means that one index can be
used to predict other indices.
Kenani et al. (2013) investigate the impact of the Global Financial Crisis on 2008
toward the Integration of the Chinese and Indonesian stock markets by considering
also the volatility spillovers effects of Japan and U.S. This research is using
EGARCH model considering the importance to capture the leverage effects or the
asymmetric response in the stock market volatility. From the investigation that has
been conducted, it‟s been concluded that current stock market volatility in the Japan
and the U.S. markets have effects on the future volatility of Indonesian stock market
before the financial crisis.
18
2.2.
Literature Review
Economic studies has investigated the nature of the stocks indeces and it‟s
relationship of stock returns toward the volatility. These studies are focusing on the
condition of the market during the crisis (Kravets and Sytienko, 2013; Shin, 2005;
Pivac, Aljinovix, and Marasovic, 2010; Rjoub and Azzam, 2012; Hsu, Huang, and
Ntoko, 2013; Lee and Jeong, 2014), several studies also included some variables that
need to be considered consist of IT revolution (Takemori and Wada, 2003), stock
trading volume, exchange rate, interest rate, international stock price index, bond
trading volume, interest rate (Sabri, 2004), negative news or asymmetric information
(Casarin and Squzzoni, 2013).
Kravets and Sytienko (2013) examined the nature and characteristics of stock
indeces, they used the wavelet analysis and SSA method which also considers local
individual features from period of 2007 to mid 2012. By using wavelet analysis, it
helped the research to describe the effect of crisis on time peculiarities and volatility.
Based on their analysis, they found that fluctuations if stock indices and stock returns
are a reliable indicators of macroeconomiec realties. There are differences of stock
returns behaviour during crisis and relaxation periods around the world, there are
deep recession in Europe in early 2012 and also slow growth of major developing
countries such as Brazil, India, Russia, South Africa, and Turkey. While emerging
countries are having vulnerable condition compared to the beginning of the last crisis.
19
Shin (2005) has been proven the relationship between expected stock returns
and volatility. He investigated the condition of 14 emerging international stock
markets consist of 6 Latin American, 6 Asian, and 2 European markets. This study
based on research of daily data which converted into weekly observations from
January 1989 – May 2003. Using parametic and semi-parametic GARCH, Shin
comes to conclusion that there are positive relationship between expected stock
returns and conditional volatility but insignificant in most countries.
Pivac et al. (2010) investigated the financial crisis consist of pre-crisis within
period from January 2006 to August 2008 and response on actual global financial
crisis within the Lehman shock period in September 2008. The study focus on the
condition of developed stock markets which consist of Japan, American and German
stock markets. To analyze the stock market risk and return, Pivac et al. are using
modern (Markowitz‟s) portfolio theory. The range of expected return in pre-crisis
falls from positive values to the negative values in crisis period. While American and
German stock market are similar, there values rises in crisis period.
Rjoub and Azzam (2012) analyze the stock returns and volatility in emerging
markets. The study was done based on data from 1st January 1992 to 2nd July 2009
using closing prices data of various sectors such as banks, insurance, services and
industrial sectors in which covers from local events to regional, even global events.
By using GARCH-M model, the result shows that crisis give negative impact on
stock returns and the severe impact are happened from crash of 2008 it was proven by
the largest decline in stock prices and high volatilities.
20
Hsu et al. (2013) examined the foreign investment impact in emerging stock
markets using GARCH model. This research divide the result between foreign
investor‟s most favored and least favored stocks. Using TWSE daily data, from
period of November 2007 to December 2012, they found that most favored stocks has
lower VaR than the least favored stocks and from the most favored stock, if there‟s
high expected maximum losses, when extreme economic events happened, investors
might have high or suffer loss.
In recent studies of Lee and Jeong (2014) they have been investigate the
financial crisis from 2000 to 2012 and how this crisis effect on stock market. This
research using DCC-MGARCH method, also risk decomposition, GVAR, and CCOR
models. This study also focus on the case of Northeast Asia and Europe and they
found that Northeast Asian stock market is independent from European and global
market movement, European market‟s level of integration with Northeast Asian stock
market has rise although it‟s economically insignificant, and the least is the findings
that theEuropean and global stock market level of integration were temporary rise
during the financial crisis.
Looking through this studies that has been conducted, it has been proven and
suggested that the global financial crisis really has been able to influence the behavior
of the stock. Apart from the influence of the global crisis itself, there are also several
studies which includes some variables in their studies. From the studies that has been
conducted by Takemori and Wada (2003) which compared the performance of stock
markets before and after the East Asian currency crisis. The study draws on lessons
21
they learned from the Korean and Japan stock markets. Based on the research they
conducted, there was sharper decline happened on Korean stock but this country also
recover faster while Japan market didn‟t recover quickly. This condition was resulted
from the IT revolution in which this two countries act in different ways.
Sabri (2004) identified the stock return volatility and market crisis in
emerging economies consist of five countries including Mexico, Korea, South Africa,
Turkey, and Malaysia. This research covered investigation during period of 1997 to
2000. This research found that both local and international factors can effect the price
volatility in emerging markets. From the research that has been conducted it revealed
that stock trading volume and exchange rate are the variables that has the highest
correlation toward the changes of emerging market‟s stock price. And each factors
such as interest rate, international stock price index, bond trading volume, interest
rate give varied impact toward stock price volatility. And from all these factors that
has been mentioned, Meanwhile it was revealed that inflation rate is the least positive
correlation to the stock price volatility.
Casarin and Squzzoni (2013) investigated the relationship of negative news
with stock market volatility. This research focus on investigating the 2008 – 2009
crisis period. In this research, they found the importance of press media as they can
give influence at how investor view the crisis. Investor would move their money,
investment according to the major media reported and this kind of action would give
implication toward their, mood, investment decision, debate on politics of economic
22
measurement, etc. This kind of issue shows the importance of reliable, competent
information and also the responsibility and ethics of financial press.
2.3.
Hypothesis Development
Based on these theoretical basis and looking through the previous study of
stock return volatility and economic cycles that has been conducted, the author
develop hypothesis that would like to be analyse which consist of Hypothesis 1 to
Hypothesis 4, there are;
H1: If there‟s good economic condition, then stock return increases.
Hypothesis 1 proposes the positive correlation between economic condition
and stock return. It is based on the literature and deductive reasoning. The economic
condition is distinct by the news. One of the researches that support this hypothesis is
based on the research of Djamil et al. (2013) found that stock returns are mostly
determined by external factors that were consist of inflation, exchange rate, socioeconomic conditions, etc. Basically the good economic condition appear in
correspondence from recovery after the crisis condition, economic booms or
expansions. The measurement of good economic condition in this research, will be
using the GDP growth, as explained by Mankiw‟s (2008) book of Principles of
Economics, the best measure of economic well being is by evaluating the GDP. With
the economic grows too fast or too slow, it will give bad effect such as recession or
23
inflation. According to economist, the ideal GDP growth rate would be around 2%3%. Using the GDP growth rate as the measurement of economic condition, in this
research will try to determine how does economic condition will relate or effect the
stock return.
H2: If there‟s good economic condition, then the risk premium decreases.
Hypothesis 2 employs the relationship between economic condition and the
risk premium (trade off between risk and return). To analyze the risk premium in this
research is by looking at the difference between the market rate and the risk free rate
(Rm-Rf). There are several conditions regarding risk premium, several research found
the increases in risk premium during bad times but not all of the market experience
the same, considering each countries has it‟s own economic condition. This
hypothesis is supported from research conducted by Mendonca and Nunes (2011) in
their research of Brazilian economic experience, which come to conclusion from their
research that good economic condition, with stabilizes public debt and GDP ration
resulted to the low risk premium.
H3: Bad news (information asymmetry) increases the volatility of stock return.
Hypothesis 3 proposes negative autocorrelation between information
asymmetry and return volatility. It is based on the proposition of the importance of
information that would give implication toward investor in making decision.
Hypothesis 3 was based on Chiang et al. (2007) who conduct research on five stock
24
markets. In their research, they found that negative news will cause decline in
national stock returns. In which it explained that when bad news hit the markets, the
stock return become more volatile and persistent. Volatility of the stock would be
determined by examining the standard deviation of each country.
H4:There is co-integration between US market and four Asia markets during financial
crisis.
Hypothesis 4 proposes the co-integration between US market and Asia
markets. This hypothesis was supported by the research that has been conducted by
Royfaizal et al. (2009). Although in each period shows different result in which
there‟s no co-integration on pre-crisis period and yet they also found that there are
relationship among markets during crisis period and post-crisis period.
To support the hypothesis, the main focus of the research will be to analyze
financial crisis that happened since 1997 to first quarter of 2014 was classified by
Lukanima and Swaray (2013); Stunda which consist of eight periods there are; The
Asian Financial Crisis, The Post Asian Economic Crisis, The Global Economic
Boom, The Pre-Global Financial Crisis, The Global Financial Crisis, The Post Crisis
of Economic Recovery, The Greece Debt Crisis, and Post Crisis Period of Greece
Crisis.
25
THEORETICAL FRAMEWORK
2.1.
Theoretical Background
This chapter will discuss and review the theoretical concept that would be
used as the basic ideas in this research. This discussion would be a guide to help
understand and give insight to solved the problem in this research. Looking through
the importance of the nature of the stock, it is important to understand how the
behavior of stock in a country itself and how the global economic changes affect it,
there are several studies that has been conducted by the researchers that examining
stock markets during economic crisis. Focusing on three main key variables to
understand the connection between economic cycles and stock return volatility there
are consist of stock return volatility, risk premium, also information asymmetry.
2.1.1. US and Asian market
US market is well known as the biggest market and the changes that happened
in this market will surely affected the other countries whether it is direct or indirect
and that‟s the reason why the integration or interrelationship of the biggest market
and other markets should be conducted. Meanwhile despite the biggest market,
there‟s also market that keep growing which is the East Asian market. East Asian
countries have reaches certain dynamic growth with the high levels of investment and
savings, this countries has attracted the corporates attention and also the western
11
investors. From the western point of view, east Asian countries are seen as the
potential source of funds and investor sees this as a good opportunity to make their
international portfolio in order to spread or minimized the risk in their portfolio.
That‟s why it would be interesting to analyze the behavior of the Asian markets and
how does these markets react toward the global economic events. (Swaha, 1993)
2.1.2. Global Economic Events
With the globalization and the development in the technology, capital markets
of each country are closely interconnected to one another. As a result of global
economic events many countries were affected whether it is direct or indirect way.
Some countries will become unstable and suffer from the events and that‟s the reason
why the effect of the global economic events that happened need to be analyzed by
the researchers.
Lukanima and Swaray have provided the periodical sampling of
each global economic event that has happened even since 1990, which shows in the
table below.
12
Table 2.1
Periodical Sampling of Global Economic Events since 1990
Global Economic Events
Pre Asian Financial Crisis
(02/02/1990 – 01/07/1997)
The Asian Financial Crisis
(02/01/1997 – 30/03/1999)
The Post Asian Economic
Crisis
(01/04/1999 – 31/12/2002)
The Global Economic
Boom
(02/01-2003 – 31/07/2007)
The pre Global Financial
Crisis
(01/08/2007 – 16/03/2008)
The Global Financial Crisis
(17/03/2008 – 31/03/2009)
The Post Crisis: Economic
Recovery
(01/04/2009 – 30/04/2010)
The Greece Debt Crisis
(01/05/2010 – 15/12/2011)
Description of Economic Condition
The period of prelude to the 1997 crisis
The beginning crisis in Thailand of Thai Baht
financial collapse followed by the Thai government
decision.
The economic recovery where by the end of 2002,
countries that were affected by the Asian Financial
Crisis had slowly recover.
Economic boom resulted from four major factors
consist of high commodity prices, booming
international trade, exceptional financing conditions,
and high levels of remittances.
The beginning of the U.S. crisis which reverse the
global economic boom condition
US Investment Bank collapsed resulted to the Global
Financial Crisis.
The recovery period which shown by the
improvement of the stock performance
Greek governments have been consistently and
deliberately misreported the country‟s economic
statistics and this resulted to the fear from the market.
The “road to recovery” where many public
companies started to recover.
Post Crisis Period: Greece
Crisis
(16/12/2011 – 31/06/2014 )
Source: Lukanima and Swaray (2013: 56); Stunda (2014:43)
2.1.3. Stock Return Volatility
Stock price volatility received great attention for investors and it is
important aspect that need to be understand before deciding to invest money in
the market. There are several research that has been conducted regarding the
13
behaviour of the stock return volatility (Urooj et al, 2009; Mishra and Rahman,
2010).
Urooj et al. (2009) in their research, they examine the stock volatility of
KSE 100/ Karachi stock exchange from period November 1992 to January
2008. By using ARCH/GARCH model, the researcher has found that KSE 100
has volatility clastering, leptokurtosis and asymmetry and they found that
there‟s pattern existed in the stock price returns in this market.
Mishra and Rahman (2010) analyzed the dynamics of stock return
volatility on India and Japan. They implement the TGARCH-M model in their
research. Based on their research they found that the Japan stock market is
more effiencient compared to India. They also found the evidence of the effect
of asymmetric information in both countries, it shown by how India‟s market is
affected by the good news, meanwhile Japan is more influenced to the bad
news.
2.1.4. Risk Premium
Risk premium is one of the great interest that need to be considered by the
investor as their bear the risk from the market.
Dictionary of Financial And Business Terms defined risk premium as “the
reward for holding rhe risky market portfolio rather than the risk-free asset.
The spread between Treasury and non-Treasury bonds of comparable
maturity.” (p.124)
14
With the global crisis that has happened, it gives significant impact toward the
market especially it effects the risk and return of the market. Several research has
been conducted to understand how the global crisis able to affect the risk premium of
the market. One of the research by Bishop et al. (2011) found the link between
increases in the market risk toward the decreases in equity values. In their studies,
they suggest to adjust the market risk premium to reflect the global financial crisis
with the use of historical average MRP or forward looking risk premium which used
to estimate the cost of equity. Using this methodology, they would expect a view of
forward cost of equity which is consistent with the current condition of the market
and with the debt spreads.
On the other hand, the study by Hall (2012) that responses toward the
previous study point out the inconsistency of the adjustment of risk premium to
reflect the global financial crisis by Bishop et al. (2011). In his paper, he underlying
the fundamental inconsistency with its measurement problems especially between the
short term and long term MRP. But still this kind of issues are still being debatable
until these days and more research should be conducted to help investor and give
broaden knowledge in the financial studies in the future.
2.1.5. Information Asymmetry
According to Kolb and Rodriguez‟s (1992) book of Financial Management,
information asymmetry or asymmetric information is the situation in which investor
has the same information regarding the firm, in which not every information they get
15
are the same or condition where two parties possess information about same subject
and the information itself has different value.
This information asymmetry appears anywhere and has been conducted by
many researchers. One of the examples is shown by Chang (2003) who analyzes the
barriers to information flow in which examined the information asymmetry happened
in emerging market by studying and comparing between foreign and expatriate
analysts. The researcher uses the daily data of stock price of TSE or Taiwan Stock
Exchange and also listed companies data. In this research, it was underlined that the
expatriates‟ trade on their superior information, while foreign does not trade on their
information, but by having expatriate recommendations. The result of this research
shows that the expatriate analysts outperform foreign on the profitability of
portfolios.
2.1.6. Co-integration
Globalization has resulted to the closely interconnection of each countries and
it easily influence the economic condition of each countries with this basic, the cointegration test has been conducted by many researchers in order to examine the long
run relationship among selected variables. The relationship among stock markets also
has been examined by many researchers and their result remain controversial. Zerren
and Koc (2013) analyzed the integration between Turkey stock markets and G8
countries consist of US, UK, Japan, France, Germany and Canada. In their research
they found the cointegration of Turkey and these countries in long term relation. By
16
conducted the co-integration test it will influence the investor decision in making
their portfolio especially in order to decrease the risk of their portfolio.
Recent study by Sum (2013) also conducted the co-integration test between
United States and Europe and in his research, with the changes that happened in the
structural policy of one country it can give a direct or indirect effect toward the others
that‟s why by taking this into consideration, Sum also put the economic policy
uncertainty that has happened in the countries into account . The research has found
the long run interconnections in economic policy uncertainty by looking through the
economic conditions between US and European countries.
Royfaizal et al. (2009) investigated the international linkages or relationship
between ASEAN and US stock markets. In this research, the sample of ASEAN
countries used mainly are Malaysia, Singapore, Philippines, Thailand, Indonesia,
China, Japan, and Korea. All of these countries are thoroughly investigated its
relation with US markets since the ASIAN financial crisis. Using the co-integration
test, they come into conclusion that there‟s no significant co-integration among
ASEAN and US markets on pre-crisis period, meanwhile during crisis and post-crisis
period there‟s long run relationship in those stock markets between those countries.
Kassim (2012) investigated the nature of stock market integration by
examining Malaysian stock market with two biggest stock markets which are US and
Japan‟s stock market. By conducted the co-integration tests which able to examine
the existence of long-run relationship among variables. The research findings shows
the nature of integration among Malaysian stock market with US also Japan changes
17
over period of crisis that‟s why this study proof the country‟s vulnerability toward the
financial shocks.
Dobano (2013) tried to analyze the causal relationship between fluctuations in
Latin American stock market after financial crisis using Granger Causality test. This
research investigates the short run and long run relationship by see the possibilities of
difference in returns. From this research it shows that there‟s actually no significant
difference in mean returns. And from the evidence of short run and long run
performance, it reflect that in the short run, among international indices there‟s
bidirectional causality, but this is not the case with the emerging stock indices with
international stock indices. Meanwhile in the long run, there‟s co-integration between
Latin American Indices and international indices which means that one index can be
used to predict other indices.
Kenani et al. (2013) investigate the impact of the Global Financial Crisis on 2008
toward the Integration of the Chinese and Indonesian stock markets by considering
also the volatility spillovers effects of Japan and U.S. This research is using
EGARCH model considering the importance to capture the leverage effects or the
asymmetric response in the stock market volatility. From the investigation that has
been conducted, it‟s been concluded that current stock market volatility in the Japan
and the U.S. markets have effects on the future volatility of Indonesian stock market
before the financial crisis.
18
2.2.
Literature Review
Economic studies has investigated the nature of the stocks indeces and it‟s
relationship of stock returns toward the volatility. These studies are focusing on the
condition of the market during the crisis (Kravets and Sytienko, 2013; Shin, 2005;
Pivac, Aljinovix, and Marasovic, 2010; Rjoub and Azzam, 2012; Hsu, Huang, and
Ntoko, 2013; Lee and Jeong, 2014), several studies also included some variables that
need to be considered consist of IT revolution (Takemori and Wada, 2003), stock
trading volume, exchange rate, interest rate, international stock price index, bond
trading volume, interest rate (Sabri, 2004), negative news or asymmetric information
(Casarin and Squzzoni, 2013).
Kravets and Sytienko (2013) examined the nature and characteristics of stock
indeces, they used the wavelet analysis and SSA method which also considers local
individual features from period of 2007 to mid 2012. By using wavelet analysis, it
helped the research to describe the effect of crisis on time peculiarities and volatility.
Based on their analysis, they found that fluctuations if stock indices and stock returns
are a reliable indicators of macroeconomiec realties. There are differences of stock
returns behaviour during crisis and relaxation periods around the world, there are
deep recession in Europe in early 2012 and also slow growth of major developing
countries such as Brazil, India, Russia, South Africa, and Turkey. While emerging
countries are having vulnerable condition compared to the beginning of the last crisis.
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Shin (2005) has been proven the relationship between expected stock returns
and volatility. He investigated the condition of 14 emerging international stock
markets consist of 6 Latin American, 6 Asian, and 2 European markets. This study
based on research of daily data which converted into weekly observations from
January 1989 – May 2003. Using parametic and semi-parametic GARCH, Shin
comes to conclusion that there are positive relationship between expected stock
returns and conditional volatility but insignificant in most countries.
Pivac et al. (2010) investigated the financial crisis consist of pre-crisis within
period from January 2006 to August 2008 and response on actual global financial
crisis within the Lehman shock period in September 2008. The study focus on the
condition of developed stock markets which consist of Japan, American and German
stock markets. To analyze the stock market risk and return, Pivac et al. are using
modern (Markowitz‟s) portfolio theory. The range of expected return in pre-crisis
falls from positive values to the negative values in crisis period. While American and
German stock market are similar, there values rises in crisis period.
Rjoub and Azzam (2012) analyze the stock returns and volatility in emerging
markets. The study was done based on data from 1st January 1992 to 2nd July 2009
using closing prices data of various sectors such as banks, insurance, services and
industrial sectors in which covers from local events to regional, even global events.
By using GARCH-M model, the result shows that crisis give negative impact on
stock returns and the severe impact are happened from crash of 2008 it was proven by
the largest decline in stock prices and high volatilities.
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Hsu et al. (2013) examined the foreign investment impact in emerging stock
markets using GARCH model. This research divide the result between foreign
investor‟s most favored and least favored stocks. Using TWSE daily data, from
period of November 2007 to December 2012, they found that most favored stocks has
lower VaR than the least favored stocks and from the most favored stock, if there‟s
high expected maximum losses, when extreme economic events happened, investors
might have high or suffer loss.
In recent studies of Lee and Jeong (2014) they have been investigate the
financial crisis from 2000 to 2012 and how this crisis effect on stock market. This
research using DCC-MGARCH method, also risk decomposition, GVAR, and CCOR
models. This study also focus on the case of Northeast Asia and Europe and they
found that Northeast Asian stock market is independent from European and global
market movement, European market‟s level of integration with Northeast Asian stock
market has rise although it‟s economically insignificant, and the least is the findings
that theEuropean and global stock market level of integration were temporary rise
during the financial crisis.
Looking through this studies that has been conducted, it has been proven and
suggested that the global financial crisis really has been able to influence the behavior
of the stock. Apart from the influence of the global crisis itself, there are also several
studies which includes some variables in their studies. From the studies that has been
conducted by Takemori and Wada (2003) which compared the performance of stock
markets before and after the East Asian currency crisis. The study draws on lessons
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they learned from the Korean and Japan stock markets. Based on the research they
conducted, there was sharper decline happened on Korean stock but this country also
recover faster while Japan market didn‟t recover quickly. This condition was resulted
from the IT revolution in which this two countries act in different ways.
Sabri (2004) identified the stock return volatility and market crisis in
emerging economies consist of five countries including Mexico, Korea, South Africa,
Turkey, and Malaysia. This research covered investigation during period of 1997 to
2000. This research found that both local and international factors can effect the price
volatility in emerging markets. From the research that has been conducted it revealed
that stock trading volume and exchange rate are the variables that has the highest
correlation toward the changes of emerging market‟s stock price. And each factors
such as interest rate, international stock price index, bond trading volume, interest
rate give varied impact toward stock price volatility. And from all these factors that
has been mentioned, Meanwhile it was revealed that inflation rate is the least positive
correlation to the stock price volatility.
Casarin and Squzzoni (2013) investigated the relationship of negative news
with stock market volatility. This research focus on investigating the 2008 – 2009
crisis period. In this research, they found the importance of press media as they can
give influence at how investor view the crisis. Investor would move their money,
investment according to the major media reported and this kind of action would give
implication toward their, mood, investment decision, debate on politics of economic
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measurement, etc. This kind of issue shows the importance of reliable, competent
information and also the responsibility and ethics of financial press.
2.3.
Hypothesis Development
Based on these theoretical basis and looking through the previous study of
stock return volatility and economic cycles that has been conducted, the author
develop hypothesis that would like to be analyse which consist of Hypothesis 1 to
Hypothesis 4, there are;
H1: If there‟s good economic condition, then stock return increases.
Hypothesis 1 proposes the positive correlation between economic condition
and stock return. It is based on the literature and deductive reasoning. The economic
condition is distinct by the news. One of the researches that support this hypothesis is
based on the research of Djamil et al. (2013) found that stock returns are mostly
determined by external factors that were consist of inflation, exchange rate, socioeconomic conditions, etc. Basically the good economic condition appear in
correspondence from recovery after the crisis condition, economic booms or
expansions. The measurement of good economic condition in this research, will be
using the GDP growth, as explained by Mankiw‟s (2008) book of Principles of
Economics, the best measure of economic well being is by evaluating the GDP. With
the economic grows too fast or too slow, it will give bad effect such as recession or
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inflation. According to economist, the ideal GDP growth rate would be around 2%3%. Using the GDP growth rate as the measurement of economic condition, in this
research will try to determine how does economic condition will relate or effect the
stock return.
H2: If there‟s good economic condition, then the risk premium decreases.
Hypothesis 2 employs the relationship between economic condition and the
risk premium (trade off between risk and return). To analyze the risk premium in this
research is by looking at the difference between the market rate and the risk free rate
(Rm-Rf). There are several conditions regarding risk premium, several research found
the increases in risk premium during bad times but not all of the market experience
the same, considering each countries has it‟s own economic condition. This
hypothesis is supported from research conducted by Mendonca and Nunes (2011) in
their research of Brazilian economic experience, which come to conclusion from their
research that good economic condition, with stabilizes public debt and GDP ration
resulted to the low risk premium.
H3: Bad news (information asymmetry) increases the volatility of stock return.
Hypothesis 3 proposes negative autocorrelation between information
asymmetry and return volatility. It is based on the proposition of the importance of
information that would give implication toward investor in making decision.
Hypothesis 3 was based on Chiang et al. (2007) who conduct research on five stock
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markets. In their research, they found that negative news will cause decline in
national stock returns. In which it explained that when bad news hit the markets, the
stock return become more volatile and persistent. Volatility of the stock would be
determined by examining the standard deviation of each country.
H4:There is co-integration between US market and four Asia markets during financial
crisis.
Hypothesis 4 proposes the co-integration between US market and Asia
markets. This hypothesis was supported by the research that has been conducted by
Royfaizal et al. (2009). Although in each period shows different result in which
there‟s no co-integration on pre-crisis period and yet they also found that there are
relationship among markets during crisis period and post-crisis period.
To support the hypothesis, the main focus of the research will be to analyze
financial crisis that happened since 1997 to first quarter of 2014 was classified by
Lukanima and Swaray (2013); Stunda which consist of eight periods there are; The
Asian Financial Crisis, The Post Asian Economic Crisis, The Global Economic
Boom, The Pre-Global Financial Crisis, The Global Financial Crisis, The Post Crisis
of Economic Recovery, The Greece Debt Crisis, and Post Crisis Period of Greece
Crisis.
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